Blackwell Oxford, ECOP Economic 0266-4658 CEPR, UKCES, Publishing, PolicyMSH, Ltd. 2005. THE TRANSITION JÉRÔME ADDA TO and DIGITAL MARCO Original TELEVISION DIGITAL OTTAVIANI Article TV 41 Digital TV SUMMARY This paper studies the role of economic policy for the transition from analogue to digital television, with particular attention to the switch off of the analogue terrestrial signal. The analogue signal cannot be credibly switched off until almost all viewers have migrated to digital, due to the policy objective of universal access to television. But before switch off, only part of the population can be reached with the digital signal. In addition, those who are reached need to spend more to upgrade their reception equipment than after switch off, because the capacity to increase the power of the digital signal will be made available only then. After reviewing the competitive structure and the role of government intervention in television markets, we present the early experience of a number of industrialized countries in the transition to digital television. We then formulate a microeconometric model of digital television adoption by individual viewers. The model is calibrated to UK data and simulated to predict the impact of government policies on the take-up of digital television. Policy makers can affect the speed of take up of digital television by: (1) controlling the quality of the signals and the content of public service broadcasters; (2) intervening in the market for digital equipment with subsidies; and (3) publicizing the conditions and date of switch off of the analogue signal. We find that if the analogue terrestrial signal is switched off only when certain aggregate adoption targets are reached, strategic delays may arise and expectations may affect the success of the switch off policy. Jérôme Adda and Marco Ottaviani 41 Original DIGITAL JÉRÔME Article TV ADDA and MARCO OTTAVIANI Economic Policy January 2005 Printed in Great Britain CEPR, CES, MSH, 2005.
DIGITAL TV 161 The transition to digital television* Jérôme Adda and Marco Ottaviani University College London; London Business School 1. INTRODUCTION The wonders of digital television have been heralded for more than two decades. 1 Compared to the old analogue technology, digital compression allows more channels to be transmitted with better image quality and improved interactive applications. Roughly six times as many channels can be broadcast with the same amount of transmission capacity as is currently used for one analogue channel. The switch off of the analogue signal could result in a large increase in the supply of television channels available to viewers or in bandwidth being freed up for other uses. This paper aims at providing a framework for discussing the policies for the transition from analogue to digital television. The transition requires that broadcasters * This research was undertaken with the support of the UK Economic and Social Research Council (research grant: RES-000-22-0385), for which we are grateful. We have greatly benefited from the experience gained while assisting the UK Department of Trade and Industry on modelling the transition to digital television, and from extremely helpful discussions with Michael Crosse and Michael Hodson, who gave us the data on consumer preferences. The results reported and the views expressed in this paper are exclusively our own and do not reflect in any way the positions of the UK government and its officials. We also thank Barry Flynn at idtv.co.uk for giving us the data on the prices of terrestrial set-top boxes. We have greatly benefited from the guidance of the editor, and from comments by Emmanuelle Auriol, Patrick Barwise, Gabrielle Demange, Philip Langsdale, Jürgen Müller and Christian Schluter. Jozsef Molnar provided valuable research assistantship. The Managing Editor in charge of this paper was Paul Seabright. 1 The US Federal Communications Commission began its first inquiry into what was then called advanced television in 1987. Economic Policy January 2005 pp. 159 209 Printed in Great Britain CEPR, CES, MSH, 2005.
162 JÉRÔME ADDA AND MARCO OTTAVIANI invest in new transmission plants and that viewers buy reception equipment to decode the digital signal. The incentives for viewers to switch to digital depend on the cost of this equipment and the availability of digital services with valuable content. In turn, content providers have few incentives to make good content available digitally until digital broadcasting attracts a large number of viewers. In addition, digital equipment also tends to be expensive if its demand is low. Due to this chicken and egg feature, digital conversion of each network requires a fair amount of co-ordination among the different stakeholders. The need for co-ordination is exacerbated by the public good nature of the delivery technology used for broadcasting. 2 Broadcast delivery is non-rival, because the reception of the signal by any viewer does not reduce the availability of the same signal to other viewers. 3 This allows a large amount of identical content (packaged in channels) to be transmitted to all the connected viewers. 4 But then a significant amount of bandwidth must be used to reach the remaining analogue viewers (even if they are not numerous), making it impossible to deploy that bandwidth for digital transmission or other uses. 1.1. Business policy This problem arises to a different extent for the three main television delivery media: terrestrial, 5 cable and satellite. The costs and benefits of transition from analogue to digital vary across platforms, depending mostly on the cost and scarcity of transmission capacity. But if digitization is economical for a platform, there is a strong case for a rapid transition so that duplication of the transmission costs necessary to reach old (analogue) as well as new (digital) viewers can be avoided. To take full advantage of digital broadcasting, co-ordination is necessary among owners of the delivery medium, providers of broadcast content, equipment manufacturers and viewers. Since costs and benefits are unevenly distributed among these players, it is natural to expect that the owners of the delivery platform would coordinate the migration. Indeed, pay television satellite operators have completed a 2 A few definitions are in order. A good is said to be non-rival if one person s consumption of the good does not reduce the ability of other consumers to consume it. A good is non-excludable if people cannot be excluded from consuming it. A pure public good is non-rival and non-excludable. Before the advent of encryption technology, over the air broadcasting was the perfect example of a pure public good. An excludable public good is non-rival. Since the cost of provision of an excludable public good is constant, the average cost decreases with the number of units sold. An excludable public good is equivalent to a natural monopoly. 3 Equivalently, the cost of delivery of any given signal does not depend on the number of (connected) viewers who actually tune in. Delivery through broadcasting is effective for the purpose of transmitting a large amount of information to many receivers. One-to-one communication (or narrowcasting ) requires instead more bandwidth and so can allow the transmission of less content. Nevertheless, in the near future it will be possible to transmit video on demand through broadband and especially optical fibre cable to the home. 4 At each point in time, each viewer then selects the channel to which to tune in. 5 Terrestrial refers to broadcasting by a land-based radio transmitter.
DIGITAL TV 163 swift migration from analogue to digital for all their viewers in a number of European countries. During the transition stage, operators have employed more bandwidth in the form of costly satellite transponder space. In order to speed up the switch by their subscribers, they have replaced millions of old analogue decoders with new digital decoders at no additional cost to their viewers. Essentially, the platform operators have internalized the externalities among the different players. 1.2. Public policy The transition to digital television might be an interesting business strategy case, but is it a public policy issue? We argue that governments have important stakes in the transition to digital terrestrial television, due to the interplay of two factors. First, governments own the radio spectrum employed for terrestrial broadcasting. This spectrum is currently used for free-to-air (FTA) television in virtually every country, and in Europe it is partly allocated to public service broadcasters (PSB), often run by government-owned corporations. Second, access by the entire population to the information diffused through television by the traditional FTA and the PSB channels is widely believed to be a democratic right. In addition, choice, plurality and competition in television markets are typically considered to be important not only for economic but also for social and political reasons. There is an inherent conflict between the economic role of the government as owner of the terrestrial spectrum, and its social objective of universal access and plurality. Viewers can enjoy the full benefits of digital terrestrial television in terms of coverage and portability only after the analogue signal has been switched off and the power of the digital signal increased. But governments have their hands tied, because it is politically difficult to switch off the analogue signal until almost all households have converted their equipment to digital. Hence viewers have limited incentives to migrate to digital during the transition stage. The Commission of the European Communities (2003a) has stressed that it does not intend to impose uniform policies across Europe, but rather to ensure that policy makers in different countries are well prepared for the switchover. 6 Given the many options available and their differential impact on the stakeholders, economic analysis has a lot to contribute to the process of policy formation. 6 See also the action plan of the European Commission on information society entitled eeurope 2005 (2002): In order to speed up the transition to digital television, Member States should create transparency as far as the conditions for the envisaged switchover are concerned. Member States should publish by end 2003 their intentions regarding a possible switchover. These could include a road map, and an assessment of market conditions, and possibly a date for the closure of analogue terrestrial television broadcasting which would enable the recovery and refarming of frequencies. National switchover plans should also be an opportunity to demonstrate a platform-neutral approach to digital television, taking into account competing delivery mechanisms (primarily satellite, cable and terrestrial).
164 JÉRÔME ADDA AND MARCO OTTAVIANI 1.3. Our approach We begin by reviewing the competitive and regulatory structure of television markets. Current conditions in television markets differ across countries due to different historical developments, driven mostly by political and geographical considerations. We also discuss the early experience of some industrialized countries in the transition process. We then develop a micro-econometric model designed to analyse the impact of policies aimed at affecting digital take up by viewers. In our model, in each period individual viewers optimally choose which delivery platform and package of channels to adopt for their primary television set. The adoption decision is inherently dynamic, because it is based on a comparison of the one-off current cost of reception equipment with the flow of associated future benefits. Current and future prices and the characteristics of platforms in terms of content and coverage are given parameters, assumed to be known by the viewers. Viewers expect the switch off date to happen at a given future date. The cost of terrestrial set-top boxes depends on its cumulative adoption, and is determined as part of the solution of the model. For illustrative purposes, we calibrate the model to the UK market by combining three main sources for data. First, we recover the consumer preferences from estimations based on a recent survey of UK viewers with hypothetical choice questions. Second, we estimate a simple model of the evolution of prices of terrestrial decoders depending on cumulative production. Third, we set the initial conditions of the model based on publicly available data of historical adoption of different platforms. We use the model to simulate the impact on take up of a number of policies that have been employed in some countries or are currently under consideration. The output of the model is used to compute the effect of these policies on consumer surplus. The paper proceeds as follows. Section 2 gives a brief overview of competition and regulation in television markets. Section 3 reviews the current status of digital switchover in some countries. Section 4 introduces our modelling methodology. Section 5 reports the results of a number of policy experiments. Section 6 concludes. 2. TELEVISION IN TRANSITION: COMPETITION AND REGULATION In this section we discuss the main features of television markets in industrialized countries and the ways in which governments intervene in these markets, with particular reference to the transition to digital television. 2.1. Television markets In most industrialized countries viewers can opt for free-to-air (FTA) television or pay television. Almost every citizen can receive a limited number of FTA channels, through
DIGITAL TV 165 a rooftop aerial that receives the analogue terrestrial signal. There are typically two classes of free-to-air channels: public and commercial channels. Public channels are typically financed by the television licence fee (in Europe), contributions by viewers (in the US) and often also through advertising. Commercial channels are instead financed mostly with advertising revenues. As explained below, access and content of FTA channels is subject to government regulation. Over the last three decades, viewers choice has drastically improved in many countries with the introduction of pay television platforms, which broadcast mostly through cable and/or satellite. Typically, pay television operators offer FTA as well as a large number of other channels, charging monthly subscription fees according to the package of channels selected by the viewers. Due to digitization of the broadcasting technology, this distinction between FTA and pay television is fading. For example, UK viewers interested in seeing more than the five FTA analogue channels often have two options. They can either sign a contract with the satellite or cable operator with a periodic subscription fee but no upfront charge for the provision of the necessary reception equipment (digital decoder, also known as set-top box, and satellite antenna if necessary). Alternatively, they can purchase a digital terrestrial decoder, enabling the reception of more than twenty free terrestrial channels without paying a subscription fee. The choice is essentially between services with different content and different payment schedules over time. Effectively, free-to-air and pay television compete in the same market for viewers, programme content and advertisers. 7 Given our focus on the retail market, we discuss content production only briefly. The key feature of this production is that it involves a high fixed cost, but negligible marginal cost with respect to the number of viewers. This is because the electronic technology allows virtually costless replication of the content, or, put otherwise, the consumption by viewers is non-rival (see footnote 2). 8 As a result, content is often made available on different platforms in the upstream market, as discussed below. We now turn to a discussion of the different stages of competition in television markets, the advantages and disadvantages of the different platforms available for broadcasting, and the digitization process. 2.1.1. Stages of competition. Before the arrival of satellite, access to pay television could mostly be provided only through cable. Due to the natural monopoly nature of cable networks, it is rare that more than one cable operator serves the same domestic residence. As a result, local cable operator had monopoly power vis-à-vis 7 See Armstrong (2002) and Rochet and Tirole (2003) on the analysis of competition in two-sided markets. 8 Note that the public good nature of content production is different from the public good nature of broadcast delivery discussed in the introduction. To appreciate the difference, notice that a film is rival in consumption if distributed through DVD, but nonrival if distributed through a broadcast network. But in both cases, the marginal cost of serving an additional viewer is very small.
166 JÉRÔME ADDA AND MARCO OTTAVIANI both viewers and programme providers. This raised the issue of allowing programme providers access to the cable network, to prevent vertically integrated cable operators from foreclosing rivals in the market for programme content. 9 With the advent of satellite and now digital terrestrial television, many households can now choose the platform with the most attractive multi-channel offer. Competition between broadcasting operators controlling different platforms takes place in three phases: Upstream market: In the upstream market different broadcasting operators compete to obtain proprietary content, and in particular premium content. Operators compete for the exclusive (and often resaleable) rights to premium programme content, such as broadcasting rights to sport events and recently released films. The outcome of competition in the upstream market affects the position of all operators in the wholesale and retail markets. Wholesale market: In the wholesale market the operator that won the upstream competition negotiates the terms of access to this content with the other operators. Operators without premium content are particularly interested in gaining access to it. The selling operator typically charges a variable fee to the buying operators for each of their viewers subscribing to the premium package. Buying operators can then offer premium content to their viewers, but have to pay the per-subscriber fee to the selling operator. Retail market: In the retail market, operators compete to attract viewers to their platform, by designing the characteristics and prices of their packages of programmes. The products offered by the broadcasters are typically differentiated both in the means of delivery and in the content of the programming packages offered. Operators frequently offer subsidized reception equipment in order to attract viewers to their platform. Pay television operators typically offer packages of basic programmes that must be taken by all subscribers. Basic packages vary across operators and usually include terrestrial (PSB and commercial) channels, as well as other channels, interactive services and radio stations. By paying a supplementary fee, subscribers can also purchase premium programmes, such as major sports events and Hollywood movies. 10 Access to premium programming is widely viewed as being crucial for attracting viewers to a platform. Note that with the increase of downstream competition, the bottleneck is now shifting upstream. While the old focus of competition policy was the access of programmes to the dominant network (controlling competing programmes), the new 9 See Waterman and Weiss (1997) and Crawford (2000) for analyses of the US experience in the regulation of vertically integrated cable companies. See Armstrong (1999) and Harbord and Ottaviani (2001) for overviews of content provision in the UK pay television market. See Crawford (2000) and Goolsbee and Petrin (2004) on competition across platforms in the US. 10 For example, in the UK in 2001 BSkyB offered a choice between three basic packages with increasing number of channels (value, popular and family) and offers two premium film channels (Moviemax and Sky Premiere) and two premium sport channels (Sky Sports 1 and 2).
DIGITAL TV 167 focus is the access of networks to the dominant premium programme (controlled by a competing network). Given our interest in the viewers platform adoption decision, this paper focuses on the retail market. Though our model treats television subscription prices as given, it is important to realize that the outcomes of retail competition heavily depend on the availability and cost of content for the competing operators, and so are affected by the first two stages of competition. 2.1.2. Delivery platforms. In the retail market there are a number of platforms that deliver television content to viewers by employing different broadcasting technologies. Currently, there are three main technologies: Terrestrial: This is the oldest and most commonly used technology for television broadcasting. Traditionally, television is broadcast terrestrially with analogue signals using the ultrahigh frequency (UHF) band. For technical reasons, the part of the electromagnetic spectrum that is particularly apt for ground-to-ground transmission is severely limited. As a result, only a very limited number of channels can be broadcast analogically. Even though analogue channels can be scrambled, analogue channels are typically available for free to everyone who tunes in. Cable: In order to be able to receive cable television, a direct cable connection from an underground cable network to the home is needed. Cable technology enables many more channels to be broadcast than terrestrial technology. Though cable television was first introduced in areas of rural America with poor terrestrial signals, cable networks now tend to be predominant in densely populated, urban areas where building the network is more economical. Satellite: Like cable, home satellite systems first developed with rural TV viewers who had limited access to other platforms and could purchase large and expensive parabolic antennas. With improvements in satellite technology, from the late 1980s commercial satellite operators began to compete with cable. In order to receive the satellite signal, there must be a clear line of sight from the receiver (also called dish ) to the broadcast satellite. Some viewers cannot access satellite signals due to terrain screening (such as mountains or cliffs), local obstructions (such as trees or neighbouring buildings) or planning restrictions. It is now also technically possible to transmit television using broadband Digital Subscriber Line (DSL) technology, which allows high bandwidth data transmission on a conventional residential telephone line. Although the current penetration of this platform is negligible, this platform is expected to grow in the future. In this study, we will disregard this platform owing to lack of market information. The average cost of reaching viewers with different delivery mechanisms depends on the population density. A highly concentrated population is cheaply served by cable, while satellite is ideal to reach areas with low population density. Each delivery platform has strengths and weaknesses:
168 JÉRÔME ADDA AND MARCO OTTAVIANI Table 1. Penetration of television platforms in the EU (2003) Country Terrestrial (%) Cable (%) Satellite (%) Austria 9.6 40.8 49.6 Belgium 5.0 93.0 2.0 Denmark 27.1 46.4 26.5 Finland 45.6 43.9 10.5 France 67.6 11.9 20.5 Germany 5.4 56.3 38.3 Greece 91.4 0.0 8.6 Ireland 35.5 35.8 28.7 Italy 84.2 0.3 15.5 Luxembourg 2.4 91.7 5.8 Netherlands 7.2 89.0 3.8 Portugal 58.1 28.7 13.2 Spain 78.5 7.1 14.3 Sweden 35.0 47.1 17.9 UK 53.2 15.6 31.3 Total EU 45.5 30.3 24.2 Notes: For each country, this table breaks down the television households by delivery platform used for the primary television set. Source: Commission of the European Communities (2003b, p. 99). The main advantage of terrestrial is higher portability, that is, the possibility of receiving the signal even with a small aerial, provided that transmission power is sufficiently strong. 11 Its main disadvantage is the severe limitation in bandwidth and limited interactivity. The advantages of cable are its high bandwidth capacity (even with analogue technology) and its high potential for interactivity (a return path built into the cable enables two-way communication). Its disadvantages are a high upfront cost of building the network and limited portability. The main advantage of satellite is its relatively low upfront cost of network construction, as this can be done by renting satellite transponder space. Its disadvantages are limited interactivity and portability. As illustrated in Table 1, EU countries differ widely in terms of the adoption of television platforms. For the purpose of the transition to digital, it is useful to classify countries according to whether they have a strong terrestrial presence, as done in the BIPE (2002) report: Terrestrial countries, with a large fraction of households viewing FTA terrestrial television. In most southern and western European countries (France, Greece, Italy, Spain, Portugal) the large majority of households receive television exclusively through the terrestrial signal. Terrestrial penetration is also strong in the UK. 11 Portability is believed to be the main advantage of the DVB-T standard adopted in Europe for terrestrial broadcasting over the American ATSC standard.
DIGITAL TV 169 Non-terrestrial countries, typically with good penetration of cable. These are mostly central and northern European countries, such as the Benelux, Germany, Austria, Denmark, Finland, and Sweden. Eastern European countries are in a similar situation. In these countries, a sizeable range of channels is already available to viewers via basic access. In our opinion, these differences are due to a combination of political, geographic and market factors. As in the case of the roll out of terrestrial television, central and local governments have played a major role in building cable networks. For example, in Germany the cable system was initially owned by the state telecommunications monopoly, Deutsche Telecom. The government also supported the spread of cable television via legislation permitting private companies to serve the last mile to the customer. More densely populated countries seem to have higher penetration of cable. This is probably because the cost of constructing the cable network is lower in a densely populated country. Small countries that share borders with many neighbours are subject to greater international interferences and so have less terrestrial spectrum available for broadcasting, resulting in higher benefits of cable over terrestrial. The high penetration of cable in some countries could be due to an initial head start of a few years. Market conditions changed with the arrival of direct-to-home satellite television in the early 1990s. The cost of connecting an additional viewer for a satellite network is relatively low, while laying new cable is more costly and time consuming. Due also to the natural monopoly nature of broadcasting, cable lost some of its commercial appeal. These circumstances could explain the differences in the penetration of delivery platforms across Europe. 2.1.3. Digitization. Broadcasting can be either analogue or digital on each of the three delivery platforms, but the costs and benefits of digitization vary: Digital terrestrial television (DTT): Digital compression technology allows roughly six times as many channels to be broadcast with the same amount of spectrum used by one analogue channel. DTT signals are received through conventional TV aerials and can be converted into analogue form by a set-top box (STB) or viewed with an integrated digital television set (IDTV). Digital terrestrial television gives viewers access to an increased supply of basic channels. Digital cable: Digitization of existing cable networks requires investments by the cable operator. It is onerous to convert existing cable networks to digital, due to the necessary re-wiring. In addition, a digital STB is required for digital reception, different from the one needed for DTT. The benefits in terms of improved interactivity are major, but the increase in channel capacity is not very valuable because existing analogue cable networks already have very high channel capacity. Digital satellite: Digital satellite is also referred to as direct to home (DTH). In addition to the satellite aerial, a specific digital STB is required for digital reception.
170 JÉRÔME ADDA AND MARCO OTTAVIANI Table 2. Digitization by platform in the EU (2003) Country Terrestrial (%) Cable (%) Satellite (%) Austria 0 4 31 Belgium 0 4 25 Denmark 0 8 45 Finland 7 2 42 France 0 32 74 Germany 19 8 22 Greece 0 0 98 Ireland 0 21 95 Italy 0 0 88 Luxembourg 0 1 72 Netherlands 6 2 100 Portugal 0 2 100 Spain 2 17 100 Sweden 13 8 100 UK 22 60 100 Notes: For each country and delivery platform, this table gives the percentage of television households with digital reception. The remaining fraction is served by the corresponding analogue service. Source: Our elaboration based on information published in Commission of the European Communities (2003b, pp. 99 and 104). There are great benefits in terms of reduced transponder costs and, equivalently, increased channel capacity for given transponder space. These three multi-channel delivery systems cover different but partially overlapping segments of the population. For example, in the UK DTT currently covers 80% of the population, cable is available to roughly 50% of the population (mainly in urban areas), and satellite is believed to cover most (96 98%) of the population (see Independent Television Commission and the British Broadcasting Corporation, 2003). As discussed below, additional DTT power to cover 95% of the population will be available only after the analogue signal has been at least partly switched off. Table 2 shows the percentage of television households with digital reception, broken down by platform and European country. While satellite networks are largely digital, cable networks are still mostly analogue, and terrestrial are almost entirely analogue. We believe that take up of digital satellite is largely due to the favourable cost/benefit analysis, while the slow adoption of digital cable is due to lower benefits associated to digitization, as well as to the more difficult financial position of cable operators. The different outcomes for terrestrial television are due to different public policies. We believe that digitization of satellite and cable does not raise direct public policy concerns, because these platforms do not use scarce UHF spectrum. Satellite and cable networks are managed by private companies. It is natural to expect that the owners of these networks will decide to digitalize broadcasting on their platform, provided that it is profitable.
DIGITAL TV 171 As we explain in more detail below, the main public policy problem arises for the digitization of the analogue terrestrial network. When analysing our model we will therefore report the fraction of television households that do not adopt one of the three multi-channel television platforms (DTT, cable or satellite) and choose to view television exclusively through the terrestrial analogue platform. 12 2.2. Television and the government Governments play a key role in allocating resources, controlling content and regulating competition in the television industry. Beyond the consumer welfare and corporate profit at stake in broadcasting markets, important non-economic repercussions, such as political democracy and social cohesion come into play. When intervening in television markets, governments have a tangled web of economic, political and social goals. As often happens when such a mix of interests is involved, the policy debate is easily tainted by partisan claims. In this section we attempt to disentangle these different goals, with the aim of evaluating the merits and drawbacks of government intervention. We then address the public policy issues related to digital transition. 2.2.1. Governance of television. In almost any country, governments effectively decide which technologies can be used for broadcasting, which broadcasters should be allowed to use these technologies and what kind of content can be shown to viewers. 2.2.1.1. Economic motives. A first rationale for government intervention is economic and is based on the technological characteristics of broadcasting. Three components are necessary for television production and consumption: (1) programming has to be produced; (2) it has to be broadcast; and, (3) viewers must have television sets to receive it. Producers, broadcasters and viewers are required to make concerted investments for the success of television. Because the return of the investment of each of these three players increases with the other players level of investment, there is some need for co-ordination to kick-start the process. Indeed, governments have been heavily involved in co-ordinating the development of television, since its inception 50 years ago. 13 In accordance with the lessons learnt in the management of radio broadcasting, exclusive licences for television broadcasters were deemed necessary in order to avoid interferences. National governments across 12 Although most households tend to have more than one television set on average, in our model we focus on the reception equipment necessary for the main television set. Many households currently view FTA analogue television from the secondary television, even though they have access to multichannel television services through their main set. Our model can be extended to consider the incentives for conversion of secondary television sets. 13 See Chapter 12 of Rohlfs (2001) for a discussion of the involvement of the US government in co-ordinating television standardization processes. See Faulhaber and Farber (2004) for an account of how licences for television broadcasting came about in the US.
172 JÉRÔME ADDA AND MARCO OTTAVIANI the globe assumed responsibility for the allocation and assignment of electromagnetic spectrum within their borders and co-ordinated with neighbouring countries in order to avoid cross-border interferences. Administrative procedures were put in place to determine the part of the spectrum allocated to television. This spectrum was then assigned to broadcasters, typically by means of bureaucratic procedures. In addition, governments actively co-operated with industry to set and often mandate common standards. The allocation of spectrum for television broadcasting is determined by international agreements, intended to avoid interferences across countries. For example, in the UK the spectrum allocated to terrestrial television is located between 470 MHz and 862 MHz in the radio spectrum in the Ultra High Frequency (UHF) band. The portion of this spectrum that can be used for broadcasting is split into 46 channel frequencies of 8 MHz each, the remaining portion being allocated to radar, VCRs and radio astronomy. In total, 368 MHz can be used for terrestrial broadcasting, in the analogue and/or the digital mode, as well as for other non-broadcast communication purposes such as wireless phones and personal communication devices. Since Coase (1959), many economists have argued that the market might be in a better position than the government to determine the allocation of the radio spectrum. According to this view, privatization would result in the spectrum being used more efficiently and in co-ordination problems coming to an end. The initial allocation of property rights could be determined by means of auction mechanisms. Retrading of the rights would also be allowed and no administrative restrictions would be imposed on how the spectrum is used (cf. Rosston and Hazlett, 2001). While we believe that privatization and trading of the spectrum should be also seriously considered for the UHF segment of the spectrum, these solutions have not yet been adopted. In addition, governments have generally not yet announced what use will be made of the freed spectrum after switch off. 14 Finally, competition policy concerns apply to the television market. Due to the presence of large fixed costs in production and network effects in distribution, this market is naturally prone to anti-competitive behaviour (cf. Motta and Polo, 1997). Competition should then be promoted in these markets, as in any other market, in order to promote economic efficiency. Special legislation has been drafted in many countries with a view to safeguarding competition in media markets. These measures are often motivated by the non-economic factors discussed below. 2.2.1.2. Socio-political motives. Government intervention in broadcasting has gone well beyond the allocation of the radio spectrum. In almost all countries, with the notable exception of the US, governments have become directly involved in the production and distribution of television content via public service broadcasters. PSB television was the natural continuation and development of public radio and started in the 1920s 14 See the discussion in Cramton et al. (1998) on the possibility of designing mechanisms to allocate the spectrum while it is still occupied by analogue broadcasters.
DIGITAL TV 173 and 1930s in most European countries. While government-controlled broadcasting has been eschewed in the US, in most European countries public service broadcasting was still the dominant mode of programme origination and distribution until the mid 1980s. Financed either exclusively by licence fees (e.g., the UK) or a combination of licence fees and advertising (e.g., Italy), public service broadcasters in Europe have been under direct state control through regulation of both transmission and content. The arguments traditionally put forward in favour of PSB are mostly non-economic in nature. There are two main socio-political reasons for government intervention. First, governments have often used broadcasting as a tool for achieving cultural objectives, often with the aim of strengthening national cultural identity. Television broadcasting is considered a merit good, akin to education (cf. Graham and Davies, 1997). In addition, governments have actively regulated content in order to preserve moral decency and quality of programmes. Second, free television is considered important for the democratic process. Freedom of speech and pluralism of information are considered fundamental rights upon which modern democracies are based. In order to preserve these rights, many Western countries have imposed stricter criteria for ownership concentration in media than in regular markets. This legislation should prevent single corporations or individuals from unduly influencing public opinion. Governments have used these objectives of quality and pluralism to justify their direct involvement in television production and the regulation of the content shown by private broadcasters. For the purpose of our analysis, the main implication of these non-economic goals is the policy of universality. Many governments see universal access to television as essential to the full social, political and economic inclusion of its citizens. 15 In practice, the universality objective has typically been attained by direct public control of terrestrial broadcasting. It is worth noting that government objectives such as universality could be achieved through regulatory interventions, without the government retaining ownership of the spectrum and being directly involved in broadcasting, as also argued by Elstein et al. (2004). Quality, pluralism and universality are thorny issues. The risk is that governments real motives for intervening in media are different. As argued by the public choice tradition, and recently empirically confirmed in a cross-country study by Djankov et al. (2003), policy interventions might unduly take place in media markets to foster the particular interests of political elites or entrenched governments. Regardless of their 15 For an extensive discussion of universal access in broadcasting see the UK Government s Communications White Paper A New Future for Communications, Chapter 3 Ensuring Universal Access (2000). The government is committed to ensure that people living in all parts of the UK, however remote, should have access to television. Serving residents in remote rural areas is expensive and not economically viable for commercial organizations. Universal access to television has so far been achieved through direct government intervention, rather than regulation of market operators. In the telecommunications industry, regulators have instead introduced schemes to give incentives to private providers for universal provision. We refer to Laffont and Tirole (2000) for a discussion of the principles of universal service policies and to Riordan (2002) for a recent review of universal service policies applied to fixed telephony. Sorana (2000) proposes the use of auction mechanisms to determine universal service subsidies. Similar incentive schemes could be used to ensure universal provision of television services through private providers.
174 JÉRÔME ADDA AND MARCO OTTAVIANI Figure 1. Evolution of multi-channel penetration in the UK Source: Ofcom (2004). motives, the purpose of our paper is to develop an analytical framework for the evaluation of the effects of the different policies that are currently under consideration. 2.2.2. Government role for digital transition. It is natural to wonder whether governments should take an active role in the transition to digital, or whether migration to the superior digital technology will take place spontaneously. Why is the transition to digital terrestrial television a public policy problem, compared to other changes in technology standards, such as those used for music records or computer operating systems? We expect governments to take an active role in the transition because of the interplay of two motives, one economic and the other non-economic. First, digital terrestrial transmission technology uses a publicly owned, rather than a privately provided network. Here the government acts as the private owner of the network, and is interested in solving the co-ordination problem associated with switching standard. The owner of a network has an incentive to internalize the externality associated with adoption by viewers, for example by subsidizing the equipment needed for adoption. 16 Indeed, BSkyB managed to convert its UK satellite network from analogue to digital in the UK within three years, starting in 1998 and finishing in 2001 (cf. Figure 1). BSkyB solved the co-ordination problem by installing the required digital STB free of charge to its existing customers. 17 Second, most governments perceive the transition to digital television as having important non-economic consequences, due to the social role of the media. According 16 This is often done by mobile phone operators and pay television networks. Essentially, well-defined property rights on the ownership of the network can alleviate the problem of network externalities. 17 More broadly, this raises the issue of privatization of the UHF spectrum, discussed above. See also Hazlett (2001) and Cramton et al. (1998).
DIGITAL TV 175 to a widely held view, an increased and more competitive supply of television channels should improve the overall flow of information in the society, with positive economic and political effects. 18 Moreover, fears that a two-tier society (divided by ease of access to information) are also present in public opinion. Operationally, universal access to the traditional FTA channels is seen as a minimal condition to avoid this digital divide. The universality objective implies that switch off of analogue television will not be feasible until almost all viewers have migrated to digital television. Switching to the digital standard is a public policy problem due to the interplay of the scarcity of available spectrum with the universality requirement. To understand this, note that the policy maker faces a resource constraint because of the limited total amount of available UHF spectrum that can be divided between analogue and digital broadcasting. At each point in time, the total terrestrial spectrum available can be allocated partly to analogue and partly to digital broadcasting, and the number and quality of digital services must be determined. Until the analogue signal is switched off, only a limited fraction of the population can be covered with DTT and this coverage has reduced power. This means that part of the population will not be able to receive the DTT signal at all, and part of the population will need to upgrade their aerials to pick up the digital signal. This upgrade would not be necessary after switch off. This means that the full benefits of digital television can only be achieved after the analogue signal has been switched off and the power of the digital signal increased. In the transition stage, viewers have limited incentives to migrate to digital. In addition, if digital broadcasting attracts few viewers content providers have little incentives to make good content available digitally. Digital equipment will also tend to be expensive if demand is low. But until almost all households have converted their equipment, it is not politically feasible to switch off the analogue signal. Since the spectrum is limited, policy makers face tradeoffs. Holding constant the coverage of analogue and the number of analogue channels, the coverage of digital can be increased only by reducing the number of digital channels. For example, in the UK the current network using 80 transmitters is capable of providing some DTT services to 80% of the population. It is not technically feasible for the entire country to receive DTT unless the analogue signal is switched off in part of the country. This tradeoff varies across countries, depending on their allocation of terrestrial spectrum and the number of existing FTA channels. 19 In conclusion, the nature of the policy makers problem is similar to that faced by private operators using other platforms with limited bandwidth, but it is exacerbated 18 See Anderson and Coate (2001) for a model of television competition in which increased availability of television channels can improve social welfare by reducing the cost of advertising. In a recent empirical paper, Djankov et al. (2003) find that concentrated (as well as public) ownership of media tends to be associated with bad social and political outcomes. See Besley and Part (2001) for a study of the effect of media competition on government accountability. 19 For example, there is more spectrum available for simulcasting in the UK than in Italy, because the UK has only five analogue channels, while Italy s spectrum is clogged up by many more local channels.
176 JÉRÔME ADDA AND MARCO OTTAVIANI by the universality requirement that it is difficult to switch off part of the nation. The political feasibility constraint does not allow governments to commit to a firm switchoff policy. The fact that the switch-off policy must then be conditional on aggregate adoption introduces strategic effects, as explained in Section 5. It is worth remarking that privatization of the spectrum will not automatically solve this problem, as meeting the universality requirement will still require intervention and regulation. Nevertheless, governments often have conflicting interests in the switchover process, being involved as owner of the spectrum as well as public broadcaster. This might make the co-ordination with commercial broadcasters who operate FTA channels and might lose from the transition to digital television, due to the increased competition with the additional digital channels. 3. EARLY EXPERIENCES In this section, we discuss the different approaches to digital transition pursued by some of the major Western countries. We study the situation in the UK, France, Germany, Italy and the US. For each country, we give a brief overview of the recent evolution in television markets and an account of the policies for digital switchover. 3.1. The UK There are five FTA channels, two public channels produced by the British Broadcasting Corporation (BBC) and three commercial channels (ITV, Channel 4 and Channel 5). The BBC is not allowed to advertise, while the commercial channels are subject to content regulation and limits on advertising. Pay television is currently available through satellite (BSkyB) or cable (NTL and Telewest). From 1998 to 2002, there was also a DTT pay television network operated by ITVDigital, which has now been replaced by an FTA digital platform run by Freeview. The strong initial growth of digital television is in part the result of a move by satellite and cable operators to switch subscribers from analogue to digital packages. By 1998, analogue multi-channel television had already penetrated some 25% of households. In 1999, the UK government declared its commitment to ensuring that terrestrial analogue broadcasting signals are maintained until the following three criteria are simultaneously satisfied: Availability. Everyone who can currently get the main public service broadcasting channels in analogue form (BBC 1 and 2, ITV, Channel 4/S4C and Channel 5) can receive them on digital systems. Affordability. Switching to digital is an affordable option for the vast majority of people. Accessibility. As a target indicator of affordability, 95% of consumers have access to digital equipment.
DIGITAL TV 177 Box 1. From the ITVDigital debacle to Freeview OnDigital (later renamed ITVDigital) was launched in November 1998 as the first DTT broadcaster in Europe. The licence for DTT broadcasting was won by a partnership between Granada and Carlton (the ITV operators) and BSkyB. However, BSkyB was forced out by competition concerns in 1997 and had no choice but to compete against the new DTT operator. Indeed, in October 1998, BSkyB began digitalizing its analogue satellite network and distributing free set-top boxes. Fierce competition for exclusive rights for premium content also ensued. While BSkyB won the competition for Premier League rights,* ITVDigital secured the rights for First Division games. Eventually, ITVDigital lost the battle and went bankrupt, at a major loss to creditors and shareholders. Following the bankruptcy of ITVDigital in the Spring of 2002, the three multiplexes for transmission of digital terrestrial television previously used by ITVDigital were awarded to Freeview. The BBC, Crown Castle and BSkyB are equal partners in DTV Services Ltd, the company formed to provide consumer and retailer support for Freeview. On 30 October 2002, Freeview launched its free digital terrestrial television (DTT) service consisting of some 30 channels and 19 radio stations. In addition to the five free-to-air terrestrial channels, viewers can receive additional BBC digital channels (such as BBC Three, BBC Four, CBeeBies, BBC News 24) and other basic channels (such as UK History, Sky News, Sky Sports News and Sky Travel) as well as text and a range of interactive services. Retailers struggled to keep up with demand for STBs for Christmas 2002 and many shops sold out of boxes. Nevertheless, critics of Freeview have maintained that the growth in this platform would level off once the initial demand had subsided. * Payments for the right to broadcast the UK s Premier League live soccer games have increased drastically over time. Until 1992, BBC and ITV acted collusively, obtaining the rights for a yearly payment of roughly 3 million. BSkyB obtained the rights for a yearly payment of roughly 37 million in 1992, 167 million per year in 1997, and 366.6 million per year in 2000. BSkyB has so far always acquired these rights under exclusive vertical contracts and has been selling the resulting premium programming directly to its subscribers. BSkyB has also been selling premium programmes indirectly to the subscribers of the competing pay TV companies in exchange for payments of per-subscriber monthly fees. See Cave and Crandall (2001) for a recent account of the role of sports rights in the broadcast industry.
178 JÉRÔME ADDA AND MARCO OTTAVIANI The UK government initially expected that these targets would be met sometime in the period 2006 10. The BBC has suggested that 2012 may be the most appropriate date for the completion of switchover. 3.2. Germany In Germany, as in other countries in central, northern and eastern Europe as well as in the US, terrestrial television broadcasting is a niche market. Since most German Box 2. The Berlin switch Berlin was the first jurisdiction to switch off the analogue terrestrial signal, in August 2003 (see Wagner and Grünwald, 2003a; Hazlett, 2003). Before the Berlin switch, the great majority of the 1.8 million TV households in the Berlin-Brandenburg area subscribed to cable or satellite television. Only 160,000 were relying exclusively on analogue reception and so had to choose between purchasing a set-top box to receive digital TV signals over the air or signing up for cable or satellite television. The Berlin-Brandenburg Media Authority (MABB) co-ordinated the switch off process by setting up a transition scheme through an agreement with the public broadcasters (ARD, ORB, SFB and ZDF), the main commercial broadcasters (ProSiebenSAT.1 Media AG and RTL Television) and the terrestrial network operator (Deutsche Telekom). In the transition phase, some of the analogue channels were switched off and the spectrum saved was used for digital broadcasting. The switchover process was accompanied by an information and advertising campaign, at a cost of less than $1.2 million. According to press reports, a competitive market for STBs swiftly developed, with retail prices starting at around $100. In order not to exclude low-income families from access to television, the government paid for STBs for some 6,000 families that were eligible for welfare benefits and were not subscribed to either cable or satellite digital networks. A budget of $1 million was set aside for this subsidy. As a result of the switchover, the number of channels available has increased dramatically (27 digital channels now exist in lieu of 12 analogue ones) and significantly less spectrum is used (the 27 digital channels occupy the same amount of spectrum as just 7 of the old channels). The federal states of Saxony, Saxony-Anhalt, Thuringia and North Rhine-Westphalia are expected to be following in Berlin s footsteps soon.
DIGITAL TV 179 households currently subscribe to cable or satellite, the switch off of the analogue terrestrial signal affects only 3 million households (out of a total of 34 million TV households) receiving television through this platform. In addition, television frequencies are controlled at the state rather than the federal level. Because of this, the country s approach to switchover is regional and has concentrated on the most populous areas. The intention is to switch off all analogue transmitters in each area after a brief period of simulcasting. Following the trial experience in the Berlin-Brandenburg area, the switch to digital is currently underway in several other regions in Germany. 3.3. France France remains a terrestrial country, with some 67% of households still on analogue terrestrial in 2002. There are five FTA channels, of which three are government owned and two commercial. A peculiar feature of France is the availability of a pay television channel (Canal+) on the analogue terrestrial platform. In addition, there are two satellite operators (Canal Satellite and TPS) serving 20.5% of the television population. The cable sector is weak and quite fragmented and is losing ground to satellite. 3.4. Italy FTA television in Italy is essentially a duopoly, with three channels provided by the government-owned broadcasters RAI, and three channels by the private group Mediaset. Cable and satellite have limited penetration, but following a recent merger the satellite operator (Sky) is now gaining market share. Box 3. The French beauty contest Digital terrestrial television is expected to be launched soon in France. The 33 DTT channels have already been allocated. The existing three analogue commercial channels have been assigned two DTT channels each (one to broadcast the original channel and another for a new channel), while eight channels have been reserved for the public broadcasting and local television. In October 2002, the French regulatory agency, the Conseil Supérieur de l Audiovisuel (CSA) allocated the remaining channels for 10 years via a beauty contest. Some of the licensees are supported by advertising and others are pay channels (Bourreau, 2004). The question of who will operate the pay platform has not yet been settled.